This article is about one of the most exciting parts of business – TAXES! Wait! Before you turn the page, bear with me at least through the next sentence. This article can save you a ton of money on taxes by showing you how to change a simple part of the way you do business.
    You want to figure out how to structure the way you do business so that each merchant you sell is actually booked on your financial statements as an acquisition, instead of a sale. Normally, when an ISO sells processing services to a merchant, any expenses related to that sale (commission, for example) are expensed in the current period, usually the same month. It seems perfectly natural to expense sales salaries, commissions, materials and overhead. Accounting rules require that any cost related to the sale of merchant contracts be expensed in the same period when the sale occurs.
    The problem is that, for the growing ISO, sales expense often exceeds revenues, sometimes by a great amount. It’s not unusual for an ISO to have negative net profits during the growth years, only to see profits emerge when sales slow as a percentage of overall business activity. One way we use to measure the relative maturity of an ISO business is to calculate the percentage of total revenues derived from POS terminal sales versus residuals. If terminal sales are more than 50% of total revenues, the ISO is still in a growth phase. If residuals are more than 50% of total revenues, then the ISO is more mature.
    A chronically negative bottom line on your profit and loss statement is not a great thing if you are trying to work with a bank, leasing company or landlord. They don’t understand our business well enough to know that this situation is normal, and in fact an indicator of healthy growth. An ISO with more than 50% of revenues from terminal sales, and good retail pricing to the merchant will have a negative profit. But, that ISO is building residuals and if need be, can shut down sales any day, instantly achieving profitable status and positive cash flow. I would bet on that ISO despite the negative profit stream because eventually that business will be very valuable.
    I look at that negative profit stream for what it is – an investment in the long-term future of the business. I would rather see an ISO with a negative profit stream due to sales than almost any other situation because that ISO is growing – and that is the key thing in this business – if you are not adding customers to your base in excess of attrition, you are dying.
    The good news about negative profits is that the IRS allows you to store them away as a Net Operating Loss Carry Forward (NOL). When residuals grow bigger than terminal sales, resulting in profitability, each dollar of profit is matched with each dollar of loss created earlier, and there is no tax for as long as the NOLs hold out. Let’s say your first year in business showed a negative profit of $200,000, and then the first $200,000 of profit which follows that start-up period would not be taxed.
    However, every dollar after that NOL is used up is taxable at ordinary business tax rates of 35%. This is where the story gets really interesting. What if you then choose to sell that portfolio? The amount you sell it for can be offset by your remaining NOL, if you have any left. But if they are all used up? Then 100% of the purchase price is taxed at the standard corporate rate.
    There is another way to think about this long term problem. It’s more advantageous to structure your portfolio as a series of small acquisitions rather than a series of sales. In a quirk of accounting rules, merchant contracts resulting from an acquisition are treated differently than merchant contracts you sell yourself. Acquired contracts are considered assets and the cost of the contracts can be depreciated over 5 years. In addition, any merchant canceling service can be written off completely in the period in which he cancels. Depreciation simply means that you take the price of the acquired asset and divide by 5, and that is your monthly expense related to the acquisition. For example, a piece of equipment costing $100,000 would be depreciated over 5 years at $20,000 per year.
    Depreciation is a great idea since it means that you can take the expense of sales and spread them over five years. This means you probably won’t be paying tax in the current period, but you also won’t be losing a ton either, and so your profit and loss statement will look better to anyone needing to see it.
    The big payoff here is when you sell your portfolio. If you acquired those merchants from other agents, then the proceeds of the sale are treated as a capital gain for tax purposes, which is much more favorable than ordinary income treatment. This one can save you a ton of money, but you have to plan ahead. The end of the year is a great time to think about this kind of thing, since we’ll all be looking at taxes again in a few months. Think now about how to make changes in your sales effort so that you can book your sales as acquisitions of merchants. You will need to get with your accountant to work out the details. One great way to do this is to ask your accountant to prepare the profit and loss statement and the tax calculations for 2004 in two different ways – one with the normal way, expensing all sales, and the other with the acquisition method. Then, assume a sale at whatever price you want at year end. See if you can detect the difference. I think you will find this exercise worth your while in the long run. n